When Does a Depression or a Recession End?

Economists' joke: A recession is when your neighbor loses his job; a depression is when you lose your job.

The point of the joke is that neither "recession" nor "depression" is well defined and so the line between them is indistinct to the point of vanishing. (Economists like to joke about depressions and recessions because they are untouched by them, especially if they have tenure.) Until sometime after World War II, all substantial economic downturns, of which there had been many, were referred to as "depressions." The 1930s depression was the gravest, at least in modern times, and so came to be called the Great Depression. Oddly, when that happened, lesser depressions, past and future, became labeled (or relabeled, in the case of the earlier depressions) "recessions." What we now call "World War I" was called before the second world war "the Great War." Yet, having decided that the 1914-1918 war was the greatest war in history in cost, including number of deaths and gravity of political consequences, the word "war" was not retired as the name of earlier conflicts. People didn't start saying "the American Civil Fight" or the "Napoleonic Fights." Yet nowadays anything that doesn't measure up to the Great Depression in terms of GDP decline or unemployment decline or some other measure of economic loss is called a "recession," including the current economic downturn--which, because of its severity (unequaled since the Great Depression) some have started calling "the Great Recession."

All this shows is that Americans' use of language is debased; and we knew that, and that I am a language fusspot. What is more interesting and important is how the media and the economics profession define a recession. (There is no accepted definition of a depression any more, except "comparable to the Great Depression.") The media define it as two consecutive quarters in which Gross Domestic Product (the market value of all goods and services sold in the economy) falls, which is crude but serviceable, except that it doesn't enable the beginning of the recession to be pinpointed to a month. The National Bureau of Economic Research uses a similar measure but looks at other economic indicators besides GDP, such as unemployment, but cannot "call" a recession when it starts because protraction is one of the criteria. It took it about a year to decide that the current "recession" (I call it a "depression," because of its fiscal and political consequences, which are looming as enormous) began in December 2007.

But the really important question is when a recession ends. The media regard it as ending when GDP stops falling; the economists when it starts rising. Both definitions are misleading, as the statistics of the current situation show.

For simplicity, assume that GDP in 2007 was 100. In 2008 it was less than four-tenths of one percent greater: hence 100.4. In the first quarter of 2009, it fell at an annual rate of 6.4 percent: that is, it declined by 1.6 percent. In the second quarter, just ended, it declined at an annual rate of 1 percent, which means that it fell .25 percent that quarter. Hence, by the end of July, GDP was 98.55, compared to 100 in 2007. Suppose it is flat in the third quarter of this year and rises at an annual rate of 1 percent in the fourth quarter (i.e., it rises by .25 percent--approximately; I am doing some minor rounding). (I am not forecasting; these are hypothetical numbers.) Then GDP for 2009 as a whole would be 98.8. That looks like a small decrease since 2007. But this ignores the GDP trend line. GDP grows at an inflation-adjusted rate (all my numbers are inflation-adjusted) of about 3 percent a year on average. Hence GDP in 2008 "should" have been 103 and 106 in 2009. At 98.8, therefore, it would be 7.2 percent below trend. Nonetheless, most journalists, economists, and government officials would say, given my numbers, that the recession had "ended" in either the third or fourth quarter of 2009.

By the same token, the Great Depression ended in 1933, when GDP began to rise, though when it began GDP was a third below its 1929 level and unemployment was at 25 percent.

It seems to me that a better definition--one that would give a more realistic picture of the business cycle--would be that a recession (or depression) ends when GDP returns to (or near) its trend line. Until that happens, the economy is in trouble and measures to speed recovery should continue to be considered. Otherwise, when GDP begins to grow, however modestly--or even when it just stops falling--people will say: the recession is over, so let's forget about the economy for a while, even if unemployment is still growing, foreclosures are increasing, defaults and bankruptcies are increasing, and, in short, the economy is performing in a completely unsatisfactory manner. Maybe nothing can be done at that stage but let economic "nature" take its course; but complacency and false optimism should be avoided.

Richard Posner is an author and federal appeals court judge. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School.
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Richard A. Posner worked for several years in Washington during the Kennedy and Johnson Administrations. He worked for Justice William J. Brennan, Jr, the Solicitor General of the U.S., Thurgood Marshall, and as general counsel of President Johnson's Task Force on Communications Policy. Posner entered law teaching in 1968 at Stanford and became professor of law at the University of Chicago Law School in 1969. He was appointed Judge of the U.S. Court of Appeals for the Seventh Circuit in 1981 and served as Chief Judge from 1993 to 2000. He has written more than 2500 published judicial opinions and continues to teach at the University of Chicago Law School. His academic work has covered a broad range, with particular emphasis on the application of economics to law. His most recent books are How Judges Think (2008), Law and Literature (3d ed. 2009), A Failure of Capitalism: The Crisis of '08 and the Descent into Depression (2009). He has received the Thomas C. Schelling Award for scholarly contributions that have had an impact on public policy from the John F. Kennedy School of Government at Harvard University, and the Henry J. Friendly Medal from the American Law Institute.